Remember the saying that “past performance is not an indicator of future success”? It shows up a lot at the end of stock market reports from investment banks/advisers, stock brokers, mutual funds and independent researchers.
The irony of that statement is that it comes after being told how well that investment did in the past and, is usually a veiled attempt to say that the future would indeed be very much be like the past.
Although everyone would like to know where the current activities will take us, the unpleasant truth is that there is simply no way to foretell the path of the market.
Today, I explain why most projections would be wrong and what investors can do about it.
First of all, the start of year is usually the season for forecasts for most market intermediaries. In an annual rite, ‘market strategists’ come out through the major media outlets and profess what they deem to be a prophetic view of the future.
Indeed, in recent weeks, the market has seen a flurry of reports all giving an opinion of where markets will be headed.
While some argue that the market is a good buy, others believe investors are best placed sitting out or investing in other assets classes. Be that as it may, what is likely, if not absolutely, is that these predictions will be wrong. But why?
One main reason is that most economic and stock models play on our biases. Most players believe that models that have accurately predicted the future are likely to forecast the future going forward.
But that is no more true than believing me when I tell you that a coin will land heads up just because I accurately predicted it would do the last 10 times.
Secondly, stock markets are not a pure science. Things like physics and maths can be completely understood. They are logical, always resulting in a pre-defined answer.
However, economists, analysts and financial advisers are dealing with an often irrational and emotional specimen: people.
Exclusion of this component has rendered most analysis hopeless. Perhaps, this point could explain why George Soros’ Reflexivity Theory, has netted himself a massive fortune.
The theory, dismissed by most academicians and business schools, captures this important element (human irrationality) in stock market analysis.
You may ask, ‘Does this mean market analysis is useless?’ Not at all. In fact, there is evidence, for example, that factors like stock market valuations affect overall market returns over periods of five years or more, and that the level of prevailing interest rates influences returns over shorter periods.
Additionally, some models do stand the test of time and there are a few smart people out there who are better predicting the future than the likes of you and I. Nonetheless, in general, we are all poor at forecasting. Therefore, since most hard-working savers heeding market calls don’t sympathetically get a financial bailout for extreme market losses, it’s best for them to question/re-question these reports. Preferably, one can avoid them by investing long-term in a broadly diversified portfolio.